RECORD OF SOCIETY
1980 VOL. 6 NO. 3
OF ACTUARIES
THE
COMMISSION
FEDERAL
TRADE
(FTC) REPORT
Moderator: THOMAS F. EASON. Panelists: RICHARD V. MINCK,
WALTER N. MILLER
i.
What is it?
2.
What is good about
3.
What is bad about it?
4.
What has been its effect on sales?
5.
What has been the industry response?
6.
What will be the eventual
LOUIS GARFIN,
it?
What will be its effect?
impact on legislation or regulation?
MR. THOMAS F. FASON: My personal view of the FIC report is that of an
indignant professional.
The papers I authored are titled "FI_ Fools The
Citizens" and the "The Whole Life Contract."
These were authored _o
restore a balanced point of view for my cumpany's field force after the
imbalance created by the sensational press accounts of the report after
its release last simmer.
I will leave technical discussion to others.
Most of my brief remarks now
are taken from a recent address tD the Nebraska Actuaries Club, a forum
which included a presentation by Mr. Mike Lynch, Chief Economist of the
FI_ and a primary achitect of the report. The Congressional Record for
November 14, 1979 includes strong lamguage authored by Douglas Bereuter,
Congressman from Nebraska.
"I can think of few federal agencies that rival the FIC in their ability
to arouse both genuine ooncern and downright outrage on the part of my
constituents.
If it is true that the FI_ has become the focal point for
critics of government over-regulation, then I can think of no federal
agency that deserves it more.., whether it is funeral directors, life
insurance salesmen, the cereal industry, or used car dealers, the story is
the same over and over again. The heavy-handed, arbitrary, arrogant
manner_ whichthisagencyand its staff pursue a mission makes one
wonder whether the charter for the agency should be extended..."
This is strong language.. If you have seen the wa_ of misleading press
reports, have counselled with insurance sales people, have attended
meetings in Washington and elsewhere as I have, you would find substantial
basis for this degree of discontent.
Mr. Minck will no doubt update us on.
the recent congressional activities dealing with legislative ve%o of
administrative rule-making activities.
I find this turn of events both
gratifying and frustrating, gratifying in that it promises some relief,
frutrating in that our system of government f_mctions best when it is not
at war with itself.
93|
932
DISCUSSION--CONCURRENT
SESSIONS
I hope this audienoe does not find my political observations annoying or
inappropriate.
I do want you to know that my activities outside of
ccaloany hours have been dominated this past year by active involvement in
the political process.
Too few actuaries have stretched their time and
intellect to grapple with the daily eductional and decision making process
of local and national goverranent. As you consider the balance of this
presentation today, I ask that you view it as something more than a
technical review of a government report.
Consider the discussion you hear
as a clear-cut example of the impact which government has today on the
future ability of private insurance enterprises to serve the needs of our
citizens.
Involvement of actuaries in the arena of politics is a
challenge I commend to you. Encouragement of swift and forceful
objections, when they are %arranted by people trained in our profession,
is essential.
As future reports and comments from a variety of sources
come to your attention, please respond.
Those actuaries with lnanagement responsibility
outside of the technical
area hear a particularly heavy burden.
When the choice of filing a
document or writing about it canes up, I hope you will choose deeper
involvement.
I turn now to the other members of the panel for their discussion
blessrs. Minck, Garkin, and Miller, the platform is yours.
MR. RICHARD V. MINCI<: In my remarks this morning I intend to try to
provide a brief background on the history of the investigation by the
staff.
I will spend some time on the calculation by the FTC staff of the
"aggregate rate of return" for the industry of 1.3 percent. Finally, I'll
share some speculations on where we might be going in the way of
regulatory activity.
I.
BAC_m0UhD
On December 15, 1976, the FTC announced a staff investigation to determine
whether adequate cost information was being provided to prospective life
insurance purchasers.
It was apparent at the outset that the staff had
determined otherwise, and that the staff intended to present permanent
life iD.surance policies in the most tmfavorable possible light by (i)
using cost indexes that would split them into "savings" and "protection"
and (2) using very low assumed term insurance rates that would result in a
very low "rate of return" being reported on the savings element.
The
announcement of this investigation occurred just shortly after the NAIC
had completed its own investigation, encompassing over four years of
effort and culminating with the adoption of a model regulation to be
enacted by the states.
In spite of the apparent _
staff repudiation of the NAIC model, and in
spite of the very clear evidence that the FIC staff had prejudged the
matter, the industry offered whatever assistance it could to the Federal
Trade Commission.
I know we tried to inject some objectivity into an
otherwise close-minded atmosphere.
In May, 1978, leaders of the business
met with the Chairman of the FIU to express concern over the course of the
investigation and to urge that the business be given an cpporttmity to
present its case to the commission before any report was either adopted or
released.
In spite of this, the staff report was released with no
opportunity for state regulators or for the business to comment.
The
THE FTC REPORT
933
report seemed to indicate that the staff had mostly worked to justify the
conclusions reached at the outset of its investigation.
During this period of time, the FI_ commissioned two research projects,
one by Professor Jacob Jacoby of Prudue University, and one by Professor
Roger Formisano of the University of Wisconsin.
The results of those
studies were not conclusive.
As witness to this fact, both the industry
and the _
cited those studies to support their diametrically opposed
conclusions.
It seems clear that the staff of the FIC was not completely
satisfied with the results of this research.
For instance, the Jacoby
research (which cost a quarter of a million dollars) was only mentioned in
a footnote and briefly stmm_arized in an appendix.
YOU might contrast this
with the prominence that the FTC gave that research in letters written to
Congressmen and state insurance departments before the report was done.
In each case it was cited as a major reason for the states not to adopt
the NAIC model regulation.
The FI_ staff seems to have concluded that there is a need for federal
regulation in the insurance business and that cost disclosure is the
proper way to achieve it. As early as 1977 they apparently intended to
promulgate a Trade Regulation Rule on cost disclosure.
In 1978 the FIC
budget request contained a request for funds for at least one and possibly
two Trade Regulation Rules on cost disclosure to be proposed during that
year. The budget, h6wever, was approved only after Congress received
assurances from the Chairman of the FTC that "contrary to its earlier
plans the FIC no longer contemplated the initiation of Trade Regulation
Rule proceedings on the subject of cost disclosure in the fiscal year
1979, but rather would seek to encourage meaningful regulation in this
area at the state level."
Well, we were not surprised that the report released on July 10, 1979 by
the _
staff was critical of the business, the whole life insurance
contract, and the NAIC and its model regulations.
We were surprised that
a report of such length, that had been so long in the making, had very
little in the way of new information or suggestions.
Their new form of
cost disclosure was the Linton Yield method which Albert Linton had
devised for a speech to the NALU in the 1920's. We ware also not
surprised by the manner in which the report was released because it was a
technique they had used before.
They sent reports to the press, about a
week in advance of their ai_pearance before Congress, with an embargo on
it. Senator Cannon, Chairman of the Senate Committee on Commerce, Science
and Transportation, cummented on that at a hearing in September: I will
quote him, "Most disturbing to me is the way in which the _TC attempted to
sell its report to the press without first giving the industry the
opportunity to review and comment on the report."
The PIC had generated a series of complaints from many businesses about
the ways in which the FI_ had oonducted its various operations.
Since the
FTC is an arm of Congress, the Commerce Committee of the Senate and the
corresponding House Cormnittee had introduced legislation to make it
more responsive to the intent of Congress.
The Appropriations bill
signed into law in late May included a provision that any regulation of
the FTC could be vetoed by the two houses of Congress.
That would not
prevent the situtation we just experienced, where they ware not issuing a
regulation but were simply doing a study, writing a report, and trying us
in the newspapers.
So the Appropriations bill also included a provls_on
934
DISCUSSION---CONCURRENT
SESSIONS
that said they could not investigate the insurance business without being
specifically requested to do so by one of the two congressional Commerce
Cammlttees.
Same lawyers have the viewpoint that the McCarran-Ferguson Act hook away
fram the FIX: any authority to regulate the insurance business and,
therefore, the FI_ had no reason or authority to investigate it. If you
acoept that viewpoint, then what happened with the current legislation
served merely to clarify the existing law. ThOugh this sounds like a
modest triuml_h, as a practical matter it seems to have had quite a
profound affect on the schedule of activity of the FI_ staff. The unit
that had been working full-time cn insuranoe is in the process of being
reassigned to other items. It had about 20 additional investigations on
its list, but most of those have been shelved.
The impression around Washington is that the history of the last year is
causing the FI_ to reexamine its methods, and that in the future it may
use methods that are more normally used by other government agencies.
However, it will take sane time before we know whether it will change.
II.
INDUSTRI_NIDERATE OF
The portion of the FIX: report that attracted the greatest attention in the
press was the claim that the industry as a whole paid 1.3% as a rate of
return for the year 1977 on its ordinary life insurance business.
This
claim, and the calculation that supported it, had nothing to do with
either disclosure or oost osmparision which were really the subject of the
report. I think it was developed simply to create headlines, and to
establish the idea that life insurance ccmpanies were cheating their
customers by crediting an outrageously low "rate of return" an their
contracts and by successfully hiding that "fact" by writing such a o_nplex
and obsecure type of contract.
Let me describe the calculation made by the F_C staff. They created a
"savings acoount" based on figures frcm a uc_6_osite annual statement for
1977. The savings ac(x)unt included 90% of life insurance reserves plus
78.6% of all dividends left on deposit by policyholders.
The 90% of life
insurance reserves figure _
from an offhand observation I'd made ten
years earlier when someone from the press asked what cash values were
relative to reserves.
I said, "Well they are less than the reserves,
maybe 10% less." The 78.6% figure was derived more scientifically.
They
determined that of the dividends paid by ccmpanies 78.6% went for their
individual life policies and the rest went tD group insur_
and health
insurance policies.
They looked at the $24.2 billion of premiums that
o:mpanies received in 1977 and determined that $7.4 billion was for pure
insurance.
They got that $7.4 billion figure by taking incurred claims
for the year and multiplying it by one and a half. The rest of the $24.2
billion of premiums was determined therefore to be a deposit in the
savings acoount.
There are at least three errors of some substance
in that calculation.
First, they included as deposits in the savings acoount not only the
premi_ns for life insurance, but premiums for accidental death coverage,
for waiver of premium disability coverage, and any other benefit if one
opted to purchase additional insurance etc. Clearly, such benefits have
nothing to do with "savings accounts."
THE
FTC
REPORT
935
The second error was to substitute 150% of incurred claims for the "low
cost" term insuranoe rates (used elsewhere in the FTC report) as a basis
for Linton Yield calculations.
This approach decreased the a,ount of
premitmls allocated to pure insurance by about $4 billion with a
corresponding increase in the amount allocated to deposits in savings
accounts.
The third error was to include the premiums actually charged for term
insurance, even though by the FTC definitions most term policies and
riders have no savings account attached to them, hut rather are pure
insurance.
This means that they put in as a deposit the difference
between the term premiums actually charged and 150% of incurred claims.
Now the intent of inflating the deposits to this extent is fairly clear.
The interest actually credited by c_mpanies that year to their individual
life line amounted to $12.4 billion dollars.
That amount never appears in
the FTC calculation.
They compared the amount in the savings account at
the end of the year to the anount at the beginning of the year and
ooncluded that $1.8 billion of interest _s credited.
But the remaining
$10.6 billion was completely ignored.
John Taylor, a fellow of the Society and an Executive Vioe President of
Banker's Life, testified in October before the Senate Commerce Committee.
He spent a lot of time on the errors in the FI_ calculation and if you are
interested in the numbers you can find that testimony in the ACLI General
Bulletin No. 2830, dated October 24, 1979. Some other aspects of the
problems were discussed in Best's Review in January, 1980.
As I said at the beginning, the "average rate of return" calculation got
all the headlines hut it had nothing to do with either disclosure or cost
comparison.
The FTC staff member responsible for the calculation admitted
as much at a hearing before the NAIC in Detroit last year.
In addition,
he warned that the approach should not be used for a single company as it
may produce bizarre results. The question that should be raised is, "if
it is not relevant for a company, then how relevant is it for a policy?"
III.
_
REGULATION OF DISCI/DSUSE AND COST COMPARISON
The current NAIC Model Regulation is in effect in 28 states. Four states
have the earlier version which is compatible with the current one so that
if you comply with the current one you are in compliance in 32 states.
There have been hearings in recent months in a n%m_ber of other states
which include Colorado, Maine, Massachusetts, New Mexico and New York.
Florida has enacted legislation adopting the current NAIC MDdel Regulation
as a statute.
In no cases have the ideas advanced by the FTC staff about
rate-of-return
cost indexes been ad_pted.
The NAIC has reactivated a oommittee chaired by Commissioner Hudson of
Indiana.
It will be meeting in Denver this month and will probably
propose some changes in the NAIC model.
As I understand the schedule, the
committee plans to air for discussion any proposed changes and hopes to
take action in December.
One of the ideas likely to come up is a question of the timing of giving
information to the prospective
policyholder.
The current regulation
requires delivery before taking an application unless the contract has the
936
DISCUSSION--CONCURRENT
SESSIONS
10-day free lock provision.
In that case you can deliver the information
with the contract.
I think it is almost certain that the 51_IC will
propose an amenc%Tent that would require some form of preliminary
disclosure whether or not you have a 10-day free lock provision.
I think
it will also look at the contents of the Buyer's Guide and the Policy
Stmmary currently required by the I_%IC Model. Every state that has locked
at them has felt that it would be a very simple matter to improve them.
However, no recurrent th_ae has emerged at recent hearings.
In stmmary, the future activity in
concentrated almost exclusively at
over the next couple of years. My
ore more edition and will probably
this particular area will be
the state level and will probably occur
guess is that the NAIC Model will have
be adopted some time in 1981.
MR. IDUIS GARFIN:
Tom Eason has given me a very heavy charge. Not only
am I supposed to speak as a statesman hut possibly as the conscience of
the actuary. I have to confess that I did say, "this is the time for
statesmanship," hut I didn't realize I was volunteering for the job. I'm
afraid that my comments will fall short of statesmanship but you can be
sure that I make them in good ocnscience.
I will speak first on what is bad about the report and then more briefly
on what's good about it. It seems that the basic problem lies in
the faulty premise that the primary cc_petitive factor to be considered is
the "rate of return" on the "savings element" of cash value life
insuranoe, as compared with the rate of return on alternative savings
vehicles. This rate of return is then taken also as the only true
ccmparison a_ong life insurance policies.
For exanple, the report says,
on page 77, "The rates of return (which are an accurate measure of costs)
show an immense variability ...." A little earlier on page 70 it says,
"The following analysis of the correlation between premitm_ and real cost
demonstrates the dubious reliability of premitms as a predictor of real
cost." The analysis, of course, uses the average annual rate of return as a
measure of "real cost." Again on page 92 it says, "Although the rate of
return is not the only thing a person should consider in choosing between
term and whole life, it is certainly an important factor." This quote is
particularly revealing, because the rate of return has nothing to do with
term insurance but rather with the unmentioned alternative
savings.
Not only is this rate of return fixation felt in the evaluation of cost
indexes, it is also the theme of the first and one of the worst findings
of the report:
"The average rate of return paid by the industry to all
ordinary life insurance policyholders in 1977 was between one and two
percent."
This finding has obviously been criticized and probably with this
criticism in mind the FIC staff said, "While the 1977 industry wide rate
of return is not of direct help to an individual ocnsu_er wondering about
the economic consequences of buying a particular policy, in our view it
demonstrates the need for effective cost disclosure."
This is a non
sequitur or possibly worse.
In order to "demonstrate the need for
effective cost disclosure," it produces information which (as Mr. Minck
has pointed out) is contrived and essentially meaningless, whether or not
it is true. Also as Dick has said, the methods used to calculate the
aggregate rate have little relation to the Linton Yield method which is
proposed in the report as the recommended basis for cost disclosure.
The
THE FTC REPORT
937
report acknowledges this in a footnote an page 25 which says, "The rate of
return on individual policies is conceptually distinct from the industry
wide rate of return discussed in Part I." As the report shows, there are
large differences in results among companies, so the treatment of
ordinary life insurance as a monolithic industry subject to a single
average rate of return can really have no relationship to cost for any
policy, to cost disclosure, or to cost oo_parison.
The publicity given to
this finding was in the nature of an indictment of the whole industry on
grounds that were far from solid.
The report also makes the considerable argument about the impact of
inflation on life insurance, particularly
non-participating
life
insurance. This illustrates again the narrow focus of the report.
The
discussion of the evils of inflation is equally pertinent - and distressing - for any fixed dollar financial oontract.
It is even more so if
the contract is paid for by a single sum as in the case of a government
bond, instead of installments over a period of time, as in the case of an
annual premium life insurance contract.
In this same context, the report
contains the highly publicized statement that, "A great many policyholders
(of old non-par policies) would be well advised to surrender their old
policies and purchase new participating or term policies."
In spite of
honorable intentions and disclaimers of "recommending the wholesale
replacement of cash value insurance policies," this kind of statement from
a government source has surely resulted in ill-advised termination or
replacement of policies.
Another thing that bothers me about the whole issue is the lingering
conviction that people do not really want to know that much about the
comparative cost of their life insurance. The report stmm_rizes two
consumer research studies by Professor Jacoby that reinforce that
conviction even though the FI_ staff reaches a different conclusion.
This
is another quotation:
"Although the low cost policy had t/hehighest annual premiums, it also
was the only policy offered by a mutual ccapany, the only
participating policy, the issuing company had the highest financial
rating and the policy had the highest 20-year cash value. Cash value,
financial rating, mutual or stock company, and dividend payment were
each assessed by more than half of all the participants
(in the
study). Furthermore, as noted above, the participant stated that
premitm_, financial rating, and cash value were the three most
important dimensions explaining their purchase decisions.
Therefore,
the fact that 82% of t_hose assessing cost indexes chose the lowest
cost policy may in large part be explained by those other policy
differences.
Therefore, the high selection rates of the lowest cost
policy do not support any inference that considers do not need cost
information."
Nobody had mentioned it, hut there is a close analogy here with the Truth
in Lending Laws. I'd like to give you a short quiz about that.
1.
How many of you have borrowed maney or have a credit card or charge
account?
I see that all of you raised a hand.
2.
How many know what the APR is? That's a smaller proportion, hut still
pretty good. For those of you that didn't raise a hand, I understand
that means the Annual Percentage Rate.
938
DISCUSSION--CONCURRENT
know how the
APR is
calculated?
SESSIONS
3.
How many
That's
pretty
good.
4.
How many have been influenced by the APR in choosing their credit
sources? In answering, remember the question is about the APR rather
than the other rates that might be quoted. Three!
How many of you are actuaries -- well, I think you get my point.
People simply do not use or pay too much attention to the things that are
provided for their information in this kind of issue. My contention is
that the public would be better served if the index and disclosure
requirements were simplified as much and as soon as possible. A
requirement could be included that additional information, perhaps of
specified items, would have to be provided if the applicant should ask for
it.
Are there any good things about the report?
I think there are some.
Mainly, it got the attention of the industry as well as a lot of other
people and it has produced a remarkably unified response, one of
indignation and a public attack on the inaccuracies and flaws in the
report. Also, I think it satisfied a lot of life insurance people that
they should be giving active support to the interest adjusted indexes and
the NAIC disclosure regulation.
This is something that should have been
done years ago. Actuaries alone couldn't have changed the course of
history, but with their support the industry might have taken affirmative
steps toward more adequate disclosure rather than staying on the defensive
over all these years.
The report has also focused attention on some things that need continuing
attention.
One is the meaning or validity of sales approaches that
emphasize the savings features of life insurance. Another is the matter
of equity between old and new policies.
The report will also have an influence on product design. We are hearing
more and more about products which are explicit combinations of
accumulation funds and term insurance. Some new non-par policies
guarantee only maximLml premiums with actual premi_ns varying based on
investment experience.
The report mentions specifically one year term
insurance renewable to age 100 which I believe is a product of fairly
recent or igin.
What should we learn from the report?
There are some things it see2as to
me which insurance companies and actuaries should be learning frcm this
disclosure scenario and others like it. Just a few weeks ago I saw a
report on an industry organization which made a distinction between
"position taking" and "research."
It said, "In positian taking, the
emphasis is on what is best for insurance cc_panies.
In policy research,
the emphasis is on what is best for what we might call 'the public as a
whole' ." Unfortunately,
the first sentence describes the basis on which
all too many positions have been taken by ocmpanies and by industry
associations - their own perceived best interest.
Increasingly,
the
evidence shows that this simply doesn't work very well in the long run.
The jockeying a_ong co_panies in the history of the disclosure issue was
typical of what happens over and over again.
The "surrender" index and
the longer durations were considered to be more favorable to mutual
companies; the "payment" index and the shorter durations, to stock
THE
FTC
REPORT
939
companies, so we ended up with both indexes at both 20-year and 10-year
durations.
Dividend scales are not guaranteed, so to deal with the stock
and mutual competitive interests, the "equivalent level annual dividend"
was invented. All are now required by the NAIC Model Regulation.
The insurance buying public was not demanding any elaborate disclosures
and even Senator Hart's earlier requests were fairly modest.
I believe
that if the insurance oompanies, spurred on by their actuaries, had risen
just a little above their competitive interests to support actively a
fairly simple interest adjusted index early in the game, much of the
subsequent pressure would have been largely defused. If the companies had
in fact started to use a common index (other than the old cost index)
widely enough to permit comparisons when required in ocaE0etitive
situations, they would have been in a much stronger position to
demonstrate that meaningful price indexes were in use for cost comparisons.
Dick Minck has mentioned the current issue of the timing of the first
disclosure to the prospect.
It is in this kind of issue that what I
call "statesmanship" is needed to provide a meaningful solution.
Insurance companies might have to forego some competitive advantage or
accept some disadvantage, agents would have to ass_,e certain burdeD_s,
insurance department regulators might have to compromise on some of their
favorite approaches in the interest of getting more enthusiastic general
support, and hopefully the critics would give a bonafide effort a chance
to work.
Actuaries might take this message from the history of cost disclosure:
"When the handwriting is on the wall, read it." We cannot anticipate all
of the issues that will arise, but when public concerns are expressed, we
should take them seriously and seek solutions.
Answers should be based on
the public good and not just on what is best for the insurance companies.
Self-serving solutions are too often short-lived and frequently backfire.
Actuaries, I believe, are supposed to be the good guys. If that means
being the conscience of your company, that's what I recommend.
MR. _%LTER N. MTn_RR:
MC_t of my remarks will be geared to some specific
questions concerning the report and its effects which our moderator, Tom
Eason, asked me to consider.
What is the long term effect of the FIC report on public comprehension
private delivery of insurance products?
and
As far as overall public comprehension of insuranoe products and the
industry is concerned, the long term effect of this report will be bad.
Critically bad? No - I'm not trying to suggest that the report will cause
severe problems in this area in the future. But whether we like it or
not, the FIX: has a generally good public image. The majority of the
American public seems to view the FIC as one of the few goverrm_ental
organizations that really is motivated to act in the best interest of the
ordinary person, the little guy. The majority of people view the FEZ
favorably as being supportive of "good" public goals and benefits for
consumers and others.
With this sort of situation, the anti-industry
stance of the FI_ cannot help but hurt us and cannot help but set back
good public understanding of our product, and the way it is sold.
940
DISCUSSION--CONCURRENT
SESSIONS
Concerning private delivery, I'd like to break my answer down into two
parts, one relating to delivery of irsurance through the traditional
agency system and the other relating to delivery via other methods.
I think the long ten_ impact on sales of irsurance through the agency
system will be beneficial.
This may seem strange after my prior remarks,
but our experience has been that - with same help on technical matters
from their home office - ccmpetent, well trained career agents have been
able to handle the problems raised by the inaccuracies and biasses in the
report without too many problems. Now, it's true that not all career
agents are as competent and as well trained as we'd like, and it's also
true, therefore, that the weaker segments of our traditional agency forces
have had same problems handling the fallout from the report; but the net
effect of all this will be that with the activities of the better trained,
more competent, ar_ stronger agents relatively unaffected and the
activities of the others hampered, there will actually be a r_t gain.
Perverse though it may seem, the effect of the report may actually be to
strengthen the necessary process of further q0grading the knowledge and
quality of traditional career life insurance agents - as well as the
markets they serve. This can't help but be beneficial in the long run°
With respect to sales activities under non-traditional methods, here I
expect that there will be scme adverse effect, at least to the extent that
the markets served hy these methods are presently concentrated in the
lower and middle economic brackets. In particular, the lower income
people (who are generally targeted by mass marketing and other methods
typical in the non-traditional area) will probably put more credence in
the report and some of its false conclusions than other groups of people.
To the extent this is true, it will hurt.
Is there a cumulative effect on the series of governmental
dealing with insurance?
investigations
I think there is, but not so much with the public as with the state
regulatory system. Right now, the NAIC (as well as a number of state
insurance departments) is re-examining the current legal and regulatory
framework with respect to cost ounparison, disclosure, and related items.
Much of this activity is to be expected and is reasonable in terms of an
on-going review of public regulatory needs in these areas. But I have no
doubt that the intensity and outoome of these activities will be at least
somewhat more stringent than it might have been if there had not been the
series of investigations referred to, culminating with the _
staff
report.
Has the industry responded adequately
to the PTC staff report?
No and yes. In an absolute sense, I'm sure that the industry rebuttals
have not reached as wide an audience as the original report, and have not
gotten the hearing they deserve. But in a real world context I would
answer "yes" because the industry, in my opinion, did as well as it could
in a very difficult situation where the dice were loaded against us. You
just cannot escape the fact that the nature of this sort of situation is
that the party that gets in the first punch is going to have a big edge.
And this was accentuated by the fact that, as Dick Minck previously
explained, the FIC staff took specific steps in order to assure maximum
exposure for their side of the story and minimum meaningful response
opportunity for the industry.
THE
FTC
REPORT
941
One thing this means, of course, is that we must not always be put in the
position of responding to our critics. We have a good story to tell and
all of us must find better, more effective ways to keep on telling it.
Another thing it means is that there will probably be an increasing number
of situations where we have to walk a tightrope, as it were. One example
of this is in the area of rate of return (ROR). The FIC staff and some
others have pushed for mandatory ROR disclosure.
Most segments of the
industry and most actuaries that I know have vigorously opposed such
mandated ROR disclosure and correctly so, in my opinion. This is because
there is strong evidence that rankings of policies using ROR are not at
all significantly different from tho6e using the interest-adjusted method
and therefore RDR can add no new information as to relative cost. Also,
RDR can give perverse results in that if any sort of realistic term rates
(i.e., those which increase as the face amount decreases) are used, the
indicated rate of return also increases as the face amount of the
permanent policy decreases.
This is absurd.
Finally, mandated ROR
disclosure under the aegis of state or federal regulatory agencies would
foster the public impression that a "buy term and invest the difference"
scheme can produce results exactly equivalent to those under a permanent
policy.
When matters like availability
of non-forfeiture
options,
settlement option guarantees on the entire proceeds, and tax consequences
to the policyowner and the beneficiary are considered, this equivalence
just doesn't exist.
To do anything that suggests it does is dangerous and
misleading the public.
But (and here's where the tightrope walking comes in) opposing mandatory
RDR disclosure does not mean that the use of RDR figures should never be
considered.
In the real world, it is a fact that ROR figures, properly
qualified and explained, can legitimately be used as part of a
conscientious defense of permanent insurance vs. some rather strange
claims made by people and organizations who claim that buy term and invest
the difference schemes are the only way to go, any time, in any situation.
Who are our friends?
Who are our enemies?
Those involved in state regulation of insurance are our friends. Or, if
they are not, they should be - not from the standpoint of being under our
thumb but from the standpoint of sharing common goals vs. some of the
issues raised by the FTC staff report.
Here is one area where we should
pay special heed to Lou Garfin's good advice.
Even if there is some pain
associated with the process, there are accords we need to reach with each
other so that we can deal better and achieve better results with our
friends.
Among our enemies are some (not all) consuaerists, some (not all) academic
people, and some (not all) in government.
But make no mistake, most of
those who qualify under my "some" are dedicated, intransigent enemies
indeed. They are out to get us. They don't respect the industry or
anyone in it. They don't recognize actuaries as anything but lackeys of
the companies who employ them. There is no devious route they will not
take in order to reach their foregone conclusions.
There are no views
which will impress them if they turn out not to agree with their
preconceived
notions.
942
DISCUSSION--CONCURRENT
SESSIONS
A good example of this latter point is that it is an article of faith with
many consumerists that leveling commissions paid %o agents will produce a"
vast reduction in the cost of the insurance we sell. Any actuary who has
examined this area knows, and can prove, that as long as lapse rates are
in the neighborhood of 15% or less for the first year and grade off
thereafter, this thesis just isn't true. But no am_ount of demonstration
can oonvince some of those who push it.
You would expect our own companies, and our managements, to be our friends
and this is largely true but not always.
In the past, I believe that a
few company managements have condoned or even instituted actions and
practices which really aren't proper if the insuranoe industry,
individually and collectively, is to make a rational response to
consumerists and similar forces.
In this respect, maybe the fallout from
the FI_ staff report is helpful in that in some of these situations,
managements will see a threat to their continued well-being if practices
such as I have referred to are continued.
But our main enemies are ourselves, the actuaries.
When non-technical
people att_ot
to grapple with difficult technical issues, we can't say,
"only we, the actuaries, u_derstand these issues and don't you guys mess
around with them." To same of us that may seem reasonable, hut to most of
the real world outside our offices it oames accross as pure arrogance, and
it does not in any way inhibit some vacutm_ being filled by people or
organizations who have become active only because as professional
actuaries we have not.
We can't continue to _
out as a profession, although it is admittedly
very difficult for the Society or any other professional organization to
take positions in areas which are fraught with public controversy.
Where
_re we when the really important basic issues of cost comparison and
disclosure started to be thrashed out? Where are we with respect to
continuation, if not intensificatien, of same rather impure and romantic
sales practices which many of us notice and too few of us attempt to
correct? Where are we with respect to fostering sound and defensible
standards for calculating dividends? Maybe we're getting somewhere here.
At least we will be if the forthcominq recommendations of the Societv and
Academy
committees working in this important area receive the attention
and - most important - the support they deserve. But if we don't support
efforts like these, we will continue to leave vacuum_ which will be filled
in ways that are not to our liking.
In this cataloguing of friends and enemies, I've so far left out the most
important group of all - the public. Where are they?. I'm not sure.
They're certainly not overwhelmingly
our en_nies but they're certainly not
overwhelmingly our friends either.
We're still in a sitatuien where we
can influence our own fate and that of the companies and the industry with
which many of us are associated.
Let's do that.
MR. E_SGN:
Panel, that was magnificent.
you all a good solid round of applause.
I think this group should give
We are not done yet - would anyone like to discuss any of the topics
presented or perhaps put a question to our panel? Please o_me to the
microphone.
THE FTC REPORT
943
MR. JERRY N. _:
I have noticed that there has been a lot of
reluctance on federal regulation.
In Canada, insuranoe is regulated
federally and it seems to have worked very well.
I'd like to know why
there is so much reluctance to have federal regulation in the U.S., as
opposed to state supervision which se_ns to cause a lot of problens.
_. MINCK: You'_
got a very happy situation in Canada where you do have
a division of regulation between the federal and dominion governments.
In
that atmosphere, in a country of your size and with the number of
csmpanies involved, it works very nicely.
I think in the U.S. we have
always been in a situation where we have had a very active set of state
regulators who have regulated all aspects of the business. It was for
that reascn that the Supreme Court held that insurance was not "interstate
uc_,,,erce"and therefore not subject to federal regulation. The way the
laws are set up you would he faced with a situation where you'd probably
have dual regulation, so it is not the option of federal or state, you'd
have both. Where we have had the experience of both theyT_ been
expensive and conflicting.
I think that it is that as much as anything
that has lead to the difference in our two countries.
MR. E_S(]N: I'd like to tell you of one new development and see if you
have a reaction to it. There are various studies proceeding on various
aspects of the cost disclosure area. The academically oriented American
Risk & Insurance Association has scheduled a progran in Chicago two months
hence. Robert Cooper who is dean of the Hubner School of the American
College is preparing a paper entitled "The NAIC and FI_ Policy Summary
Deadlock -- A Possible Compromise."
This paper investigates the
statistical correlation between rate of return and interest adjusted cost
indexes. Mr. Cooper has fou[_ an exceptionally high correlation and I
understand that his paper will be considered for publication in the CLU
Journal within the year.
I would ask this group if you're aware of any
other research, published or private, which you would like to share with
us on that subject or some other subject that might help lead us in future
developments. While your thinking on that one, I want to take a poll.
How many of you in the room have been asked to calculate or have
spontaneously calculated Lintcn Yield rates on scme of your present life
products?
Can I see a show of hands? That appears to be 60 to 70% of the
audience. Would you view expanded use of this measure, whether voluntary
or forced, as a good or an evil. Now there are two questions I'm asking
you.
Would someone stand up and comment on either of those?
MR. JULIUS VOGEL:
I would view it as an evil for a couple of the reasons
that ha_ been given before.
I think that the use of the Lintcn Yield was
intended by the FTC to get the customers to say, "Why should I put my
money into a 6% investment when certificates of deposits are earning 10%
or 12%." As far as comparing different policies are concerned, the Linton
Yield is no more or no less than the "interest adjusted net cost" turned
around. Instead of putting in an interest rate and solving for the term
insurance cost, you put in a term insurance cost and you solve for the
interest rate.
I don't see how one index can give you any more
information than the other.
There are, however, a substantial number of
people (let's say 25%) who keep their policies until death.
It seems
_o me that's where the interest adjusted net payment does have
significance and of course that kind of information is just not available
in the Lintcn Yield.
944
DISCUSSION--CONCURRENT
SESSIONS
If I may keep the microphone for one minute longer, on the matter of
buying term and investing the difference, we did a calculation at
Prudential for a typical age. We found that if a person had started 30
years ago buying whatever term insurance policy we had at the time, say a
five year term, and if we had been willing to make decremental changes in
the term insurance policies from year to year at no charge, and if the
individual had put the difference in a savings account, then after taking
taxes into ccnsideration, what would have accumulated in the individual's
savings account would be slightly less than the cash value an a Prudential
whole life policy purchased 30 years ago. After 20 years the results were
a little more equivocal.
MR. MILLER:
One of the criticisms that has been levied against the
interest adjusted method is that it is a so called snap-shot type of
method.
In other words, think of the 20 year interest adjusted net cost,
that brings into account only the 20th year cash value and none of the
intermediate cash values.
_r
though, that a Linton Yield
calculation has the s_me characteristic, it brings in only the cash value
at the end of the period over which the yield was measured.
So if you
don't like the interest adjusted metho_ because of the fact that it
doesn't take account of all the intermediate values, you don't solve your
problem by moving to Linton Yield either.
MR. FASON:
I have one other area I'd like to pique your interest in
briefly. There is another paper that will be coming out, I understand,
this one authored by a former Society president, Mr. C. L. Trowbridge.
This paper addresses the impact of adding a mortality adjustment to the
current NAIC method.
It explores the use of this double adjusted method
in evaluating the worth to a consumer of a proposed replacement.
If you
are in a practical operating position as I am, you are concerned about
that type of calculation these days and I wonder what the state of the art
is now within oompanies on methods for analyzing proposed replacements
which might come to your attention.
If someone would like to address that
I would be very happy to have you do so. Lou, I wonder if you have gotten
into that subject in your company's situation?
MR. GAB_IN:
I have to answer no to the specific question about the
technique for countering proposed replacement situations.
There is an
increased level of replacement activity recently but we don't have a
solution for it.
MR. _%SON: One thing you might like to do is to try a little different
calculation based on a rate of return analysis. What is the rate of
return if you take a policy that is five years old and calculate the
situation from now on? I think the n_bers there (since you will
obviously have amortized some of the initial expenses) oould be quite
dra_atically different and rather interesting, at least for internal
cx)nsumption. Has any one done that in his shop?
MR. JON C. CHRISTOPHERSON:
To help our field in replacement situations,
we have added an annual rate of return calculation on all ledger
illustrations for inforce business.
The results, I feel, have been
reasonable for policies that have been in force long enough to have cash
values.
The rate of return on these illustrations is significantly higher
than the average yield for the first 20 years.
THE
FTC
REPORT
945
MR. EASON:
Jon have you explored
any other methods
appealed
to you or is that the only one that you've
far?
MR. CHRISTOPHERSON:
of work on.
I have
Yes,
found
produce
valid comparisons
replacing
whole
life.
along the
done much
way that
work on so
that is the only one we have done any amount
it rather difficult
to find a method that will
of dissimilar
plans,
especially
when
term
is
MR. EASON:
AS a personal
observation
on the Trowbridge
paper I mentioned,
it does attempt
and it is rather
convincing
in pointing
out that, with a
mortality
adjustment
you can do some comparisons
of dissimilar
contracts.
Dick, a question
for you.
Did anything
regulation
discussions
to indicate
that
where replacements
were involved?
happen in the replacement
there was need to compare
model
costs
MR. MINCK:
It was clear that the regulators
felt that cost comparisons
were needed
in replacement
situations.
Moreover,
they concluded
that
there was a great advantage
to using the same comparison
systems used
with new sales to the extent that it was possible
to do so.
The use of
the methods
already in place for new sales would obviate
the need for
additional
training
of agents.
The cost comparison
situation
is
complex
enough without
having
different
systems
of comparison
in different
sales
situations.
MR. EASON:
In any event,
that model
regulation
of that sort, just disclosure
of the raw data?
does
not
require
numbers
MR. MINCK:
That model regulation
would develop
a comparison
statement
showing premiums,
dividends
and cash values
for I0 years and at age 65
for both the existing
and the replacing
contracts.
Any companies
trying
to conserve
existing
policies
would have to furnish policy
summaries
for their existing policies
on the same basis
that is required
for new
policies
by the model life insurance
solicitation
regulation.
The expenses
of developing
cost indexes
beginning
at odd durations
may discourage
some
companies
from making
such efforts.
For example,
many companies
might
not have illustrated
dividends
for the next twenty years
for a policy
that was issued in 1963 to an individual
then aged 25.
Similarly,
they
might have no computer
circumstances.
system
for
developing
MR. EASON:
Let's be clear on this.
discussed
or was it actually a part
lation?
cost
indexes
in such
Was this a proposal
that was
of the new Model Replacement
Regu-
MR. MINCK:
It is part of the new Model Replacement
Regulation.
that version
of the model regulation
has been adopted by about
states and most of the rest have a 1970 version
with different
MR. EASON:
presentation
I take
today.
it the
Let
audience
us
continue
is as satisfied
and not
fool
as
the
I am with
citizens.
However,
a dozen
requirements.
the